Nigam Arora is an engineer, nuclear physicist, author, and entrepreneur and
the founder of two Inc. 500 fastest growing companies. He is also the developer
of the ZYX Change Method
to profit from change by investing. The premise is that most money is made by
predicting change before the crowd. Arora is the chief investment officer at
The Arora Report and the
editor of four newsletters that track the ZYX Change Method. Nigam can be
reached at Nigam@TheAroraReport.com.

Apple Inc.’s just-released earnings show quite a contrast between the recent past and the near future.

The projections for next quarter are downright ugly while earnings for the last quarter are a thing of beauty. First let us examine the technicals of Apple
AAPL, -1.92%
stock and then we will move on to the fundamentals.

Prior to earnings, Apple had broken the support at $419 - $421 and then dipped below $400. Now the prior support acts as resistance. In the after-hours action, Apple moved up about $19 and broke out of the resistance at $419 - $420 as shown on the chart. I expect the stock to back and fill here, break the support at $419 - $420, and test $400.

How the stock acts around $419 - $420 level will be very telling. If Wednesday morning the stock cannot sustain over $420, it will be a negative technical signal. On the other hand, if the stock stays above $420, the next resistance level is around $440 as shown on the chart. This is also where the downward sloping trendline meets the resistance line. We expect stiff resistance in the zone of $440 - $450.

From a little bit longer perspective, trading after the earnings report has not invalidated a target of $340 set by the head and shoulders pattern traced out by Apple when it was trading around $700. If Apple breaks $400, the next major support is at $360.

The point is that trading over the next couple of days will clarify the technical picture. At the time of this writing, the technical picture is murky at best.

The beautiful first quarter

Certainly the latest-quarter earnings should not be ignored, but it is the future that matters. For the quarter Apple reported $10.09 in earnings which is about in line with the consensus but lower than the whisper numbers.

Generally it is the difference between the actual reported earnings numbers and the whisper numbers that move the stock. However, since the whisper numbers were all over the place, the usual trading interpretation from the difference between whisper numbers and actual numbers is not applicable this quarter.

Apple reported revenues of $43.6 billion ahead of the consensus of $42.4 billion. Also on the positive side, Apple sold 36.4 million iPhones compared to consensus of 35 million. iPads also did better, 19.5 million iPads were sold compared to the 18 million estimate. Apple sold about four million Macs, in line with estimates.

The reason for the stock trading up

Some market participants are encouraged that Apple has raised its quarterly dividend by 15%. A more telling indication that Apple is beginning to consider better capital allocation is that not only Apple is thinking to borrow, it is also raising its stock buyback authorization by five times to $60 billion. Obviously Apple can borrow very inexpensively; the real question is, "Is there enough innovation going on at Apple to deploy cash?"

The ugly next quarter

For this next quarter, Apple projects $33.5 billion to $35.5 billion in revenues compared to consensus of $38.6 billion. Bears are likely to seize on projected lower gross margins. Apple projects gross margins of 36% -37% for the next quarter vs. consensus of 38.5%.

From my analysis of the earnings report, the most encouraging information is that the average selling prices of both iPhone and iPad held steady. This indicates that the fears of price erosion have been overblown.

Further, the message from this information is that even though analysts and advanced tech-savvy users have caught on to the fact that Apple has not kept up with its rivals and its products no longer provide better value than its competitors, the masses are oblivious to this fact.

The average selling price of iPhone was $613 and of iPad was $449. These numbers are important because these two products together contribute 80% to 85% of Apple profits.

What to do now

Perhaps the most important principle underlying my ZYX Change Method is that nobody knows with certainty what is going to happen next. The best course of action is to focus on risk-adjusted returns using probabilities.

Of special note is that Tim Cook came across as more of a salesman on the earnings conference call in contrast with his prior calm "I could not care less attitude." This indicates he “gets it.”

If the stock is hit, and starts approaching the major support level of $365, it will make sense to add to an existing position or start a new position.

The fundamental reason is that there is a very high probability that the next quarter will turn out to be the trough quarter.

Apple is likely giving low guidance because it may be anticipating slower sales of iPhone 5 ahead of the next iPhone introduction. Further the probability is very high that Apple will introduce a low-cost phone. The introduction of a low-cost phone will launch Apple on a new revenue growth trajectory. The growth is in emerging markets and the disposable incomes in these markets are not high enough for the masses to afford existing Apple products.

Our game plan is simple. I recommended buying Apple at $131 and now we have taken profits on 90% of the position. My track record on Apple is well-documented, including at MarketWatch. The reason we keep holding the 10% position is that in our analysis Apple stock is like dry tinder and can easily catch fire on the upside to about $585.

Our tentative plan is to add to the existing position in the zone of $340 - $365. Of course it is important to note that our models are updated in real time and I believe in being nimble based on what our algorithms show.

Disclosure: Subscribers to The Arora Report are long a small position in Apple.

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